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to examine that list should rest in the authority of the Federal Trade Commission, and that application should be made to the Federal Trade Commission whether persons should have the privilege of examining that list.

Now then, the other and last thing that I wanted to add is that the Federal Trade Commission should in like manner have the right and authority to pass upon the reasonableness of the compensation of the members of the depositary committees, the depositaries, and the attorneys, of whom I happen to be one. We know that in a great many instances some of these services are negligible.

In a great many instances the members of the depositary committee do nothing except at the dictation of a banker as to a plan or scheme, and sign their name to it and bring it in and then charge very large compensation or get substantial compensation for services of a minor character, and I believe a full statement should be made.

I might add one more thing: I feel that at the time of reorganization when an advertisement is made and any statement goes out as to the depositary committee a full statement should also be made as to the interest of each of the members of that committee, what his holdings may be in the company that he is interested in reorganizing. Very often names are put down, certified by a banker, who has no interest whatsoever. Îhey are really strangers and brought in by way of good will or to do a man a good favor, and he goes down and participates in the reorganization of the company in which he has no real or substantial interest. I think if a man is going to deposit bis securities with any group he ought to know not merely the name of the man but what interest he has in the property.

That completes what I had in mind, I had not any idea of making any statement here, but Senator Bulkley suggested that I should come in and present those thoughts.

The CHAIRMAN. I am glad that you were able to make your statement. Does any member of the committee wish to ask Mr. Friedman any questions? If not, you will be excused.

Mr. FRIEDMAN. Thank you very much.

The CHAIRMAN. Gentlemen of the committee, on yesterday I requested Mr. Penn Harvey, a former director in the investment house of Harris Forbes & Co., and later a vice president of Chase Harris Forbes Cos. of New York, to outline for the information of the committee the mechanics of the origination and distribution of investment securities. I thought the committee might be interested in having such information.

Mr. Harvey, will you come forward to the committee table and give your full name, business, and address, and inform the members of the committee with respect to that particular subject.

STATEMENT OF PENN HARVEY, OF THE CHASE HARRIS FORBES

COS., NEW YORK CITY

Mr. HARVEY. Mr. Chairman, I am recovering from a broken leg. Might I be seated?

The CHAIRMAN. Certainly.

Mr. HARVEY. Might I also inquire how much time will elapse before you ordinarily adjourn?

The CHAIRMAN. As soon as we can, perhaps within half an hour. Will that be enough?

Mr. HARVEY. Yes sir.

The CHAIRMAN. You may proceed with your statement, after giving the information I have requested, in order that the members of the committee may know who

you are. Mr. Harvey. My name is Penn Harvey. Practically all of my business career has been in the investment banking business. First with the house of Harris, Forbes & Co., in which I became a director, and which according to our terminology was a partnership. That business, as the most of you gentlemen know, was absorbed by the Chase Securities Corporation, and out of that came the house of Chase Harris Forbes Cos., and I became a vice president of the new corporation.

The CHAIRMAN. What business are they engaged in?

Mr. HARVEY. Investment banking. My home address is MontClair, N.J. My business address is 60 Cedar Street, New York City, at least for the time being.

Senator KEAN. That is where you used to be?

Mr. HARVEY. Well, I made that statement because, as you may know, we are about to divorce the affiliate, so I do not know where the orphans of the storm may land. Shall I now proceed, Mr. Chairman?

The CHAIRMAN. Yes; in your own way.

Senator COSTIGAN. Let me ask you: What is the cause of the divorce to which you have referred?

Mr. HARVEY. Well, Mr. Aldrich, the president of the Chase National Bank of New York City, has announced that he is going to separate the security affiliate from the bank. And they are now taking steps to do so.

Senator COSTIGAN. So the reference was not personal?
Mr. HARVEY. Oh, no.

Senator KEAN. If you want it, I will put in Mr. Aldrich's circular in that regard.

Mr. HARVEY. I prefer that you use your own judgment about that.
Senator KEAN. Do you want it in?
Mr. HARVEY. No; but just as you like.
The CHAIRMAN. I think we might hear from Mr. Harvey first.
Senator KEAN. All right.

Mr. HARVEY. In the first place, I should like to make it clear that I am not appearing before your committee in any capacity except that of personal interest in the subject, and that I represent nobody but myself. I happened to drop in here on yesterday, because, quite naturally, I am most vitally interested in all this sort of thing, and wanted to hear the proceedings; and having been originally from Florida, I knew Senator Fletcher, and he requested me to talk to you. I had no intention in the world of doing such a thing until your chairman suggested it on yesterday.

Now, Senator Fletcher has asked me to outline the mechanics of investment banking. In the brief space of time that I have I can only touch upon the high spots. I know, from what I heard here this morning, that Senator Kean is particularly familiar with such operations and I could probably get a good deal of information from him, and perhaps I should do so rather than to try to tell him what he already knows. But I do not know how familiar all the members of the committee are with the mechanics of investment banking.

Senator ADAMS. The most of us have been victims, I take it.

Mr. HARVEY. Well, I hope you would not call that the mechanics of investment banking.

Senator ADAMS. No; perhaps not. The CHAIRMAN. You may go ahead with your statement, Mr. Harvey.

Mr. HARVEY. The investment banking business is divided into two major functions: (1) The function of originating securities; and (2) the function of distributing securities.

Now, I should like to discuss, briefly, this general subject under those two heads, trying to tell you in my own way as a practical man in this business, and I have been in it for the past 17 years, just how those functions are discharged by an investment banking house.

At the beginning we have the originating function. The originating investment house, investment banker, makes a full investigation of the project which desires to do some financing. That investigation at first is carried on, generally speaking, by some of the technical experts of the buying department of the given house. That is to say, their engineers, if it happens to be an electric power company, or a gas company, or a railroad company, the engineering expert along that particular line, who is a part of the organization, makes the first investigation. Perhaps their own lawyers would go into certain phases of it. Then we must have our own accountants, accountants in our own organization, look at it. And if we are not satisfied with that situation, and with the bookkeeping records of the corporation attempting to do the financing, we would employ independent audit experts, or certified public accountants, to make an independent audit for us.

Now, all of this, and in more detail than I have the time to give it to you, represent the preliminary steps.

The CHAIRMAN. And all of it is at the expense of the investment banking house, I take it?

Mr. Harvey. Yes, sir. Now, if such investigations indicate that it is an attractive proposition, that the securities proposed to be issued are interesting and attractive; and then if the issue is larger than the originating house wants to commit itself for a loan, it will ask some of its competitors to join with it in that particular piece of business. In so doing it would make available to its partners those that it calls into the particular deal, such information as it has secured in its original investigations; and, perhaps, furnish them what we call an advance proof of the circular. And it may be that 4 or 5, or 6 or 10 such houses would be invited to consider the particular piece of business, and take an interest as partners along with the originating house.

Now, let us assume that it is an attractive piece of business, and that all of the houses invited want to go into it. When you have gotten that far you have reached the point of the signing of a contract for the securities with the issuer, for the outright purchase of those securities. That is what we call making the commitment, making the actual contract of purchase to take up the securities and pay for them. In other words, as Senator Kean mentioned a little earlier this morning, at that point you begin to assume liability for the issue.

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The originating house makes the contract with the issuer, and signs the papers committing itself and its associates in that piece of business, to purchase from the corporation issuing the securities and to accept delivery of them, and to make payment for them at a certain time.

The CHAIRMAN. Then, under this bill the issuing corporation would have to come here to the Federal Trade Commission, file its statement, and have the securities registered.

Mr. HARVEY. Presumbaly that is it, or I would think so. From my reading of the bill, and Senator Kean by his questions of another witness has convinced me further along that line, that all that should be done before any of these negotiations can go on. But I want to say to you gentlemen that I do not see how that is possible.

Senator ADAMS. Well, as I understand the bill, before you sell a security all you have to do is to file this information, just before they are sold.

Mr. HARVEY. All right. And I should like to say to you gentlemen before I go further with my remarks, that I have not prepared myself to discuss the merits or demerits of the bill you have under consideration. And I think I would have to be a great deal better prepared before I would even attempt to do so.

The CHAIRMAN. You are simply trying to give us the mechanics of the origination and distribution of investment securities.

Mr. HARVEY. Yes, sir. But I will try at least to answer any questions you may ask.

The CHAIRMAN. You may proceed.

Mr. HARVEY. Now, I should like to make one point here which I think is the most misunderstood part of investment banking, of the functions of investment banking. It is because of the improper use of the term that has sprung up in America, particularly in the trade, and that is the term “underwriting.". The word underwriting as it is commonly used in connection with investment banking in America is a misnomer. True underwriting is an operation of this kind: let us suppose that the American Telephone & Telegraph Co. desires to raise some additional capital by the sale of additional stock. They, ordinarily as you know, would give, first, the right to their common stockholders to purchase that additional stock. They would set up that right by saying to the outstanding stock, “You have the right to purchase additional stock at a certain fixed price."

Now, let us assume that the American Telephone & Telegraph Co. wishes to put out $50,000,000 of additional stock. It needs $50,000,000 of new capital. It knows that that represents its requirements, and it wants to be perfectly sure of getting $50,000,000. They may be reasonably certain that their present stockholders will subscribe, will take advantage of the right offered to buy the new stock at the price fixed. It is usually made quite attractive, as it should be, but they want to be absolutely sure they will get the $50,000,000 out of that issue of new stock. They want to protect themselves against any failure of their present stockholders to take up all of that additional stock. In order to accomplish that purpose, to insure themselves that they will get the $50,000,000 in its entirety, they might approach their own bankers, or a group of bankers, and say "Will you underwrite this issue of new stock?” That simply means, will you guar

antee that we will sell the $50,000,000 of stock to our stockholders, or you will take over any unsubscribed portion of that stock.

Senator Adams. Is that the common understanding of the term?

Mr. HARVEY. That is the correct understanding of it. But that is not the common understanding of the term in America.

Senator Adams. I think it is the common understanding of it.

Mr. HARVEY. No, sir; because we talk of it in the trade, or I think the general public takes this view I spoke of: at the moment that we make the commitment it is called "underwriting.”

Senator ADAMS. I do not think I ever heard any other use of it than the correct use.

Mr. Harvey. I think that is a quite commonly misused term. Senator Adams, are you familiar with the operation of underwriting in the English market?

Senator ADAMS. No.

Mr. Harvey. In England, and I should like to say this to you if I may digress that far for I think you would be interested: in England an underwriting group is an entirely separate group from the banking group. The people who come in and underwrite are the same as Lloyds who underwrites insurance risks. They insure the success of the issue. They are called underwriters. And they are perfectly willing to take any unsubscribed securities for their own investment. It is like the so-called big trust companies, I mean in the English system. They buy the unsold securities. They are underwriters. Over here we use that term but it does not mean the same thing for us. Over here the underwriter buys the securities himself, and pays his money for the entire amount of the issue before he sells it. In other words, he makes a commitment. Do I make myself clear on that? It is difficult to do so. Do I make myself clear to you, Senator Adams?

Senator Adams. I have never found any confusion about it at all.

Mr. HARVEY. I thank you. I thought I had not made myself clear. When this group has been formed, and the liability has been distributed in the original banking group, and the purchase of the securities has been made, and the securities are ready for sale to the general public-and that is where the public sale of the thing would come in—a so-called selling group is organized..

The originating house, the house I have defined as the originating house, will be the manager of this whole business, and these other people will be the partners and advisors in it. The managing member of the group will send out notice to its so-called syndicate list, or dealers' list, in various parts of the country, like local dealers here in Washington, or in Denver, or in other parts of the country; and will invite them to participate in the sale of it. They will describe the issue, and say that the issue has been purchased by this group, and that they are going to offer it for sale to the public at a certain time and at a certain price; and that there is, we will say, a wholesale commission of one percent, or one and a half percent, to dealers, and they will be given the right to enter subscriptions for the new issue on those terms.

The CHAIRMAN. And that is all consigned to dealers, is not to banks or individuals?

Mr. HARVEY. Well, the bond departments of banks are included. Banks with security affiliates have been a part of the whole distributing system, and I am including them now.

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